LONDON -- It certainly wasn't music to the ears of

America Online

(AOL)

and

Time Warner

(TWX)

, but the

European Commission's

decision to open a four-month investigation into the media merger could not have come as much of a surprise.

The

European Union's

antitrust authority announced Monday that owing to concerns about the dominance the new entity may have over the distribution of music on the Internet, it had no choice but to launch what it is known as a "phase two" investigation of the proposed merger.

"As a result of the merger with Time Warner, AOL will have preferential access to the leading source of music publishing rights and music repertoire in most Member States

of the EU," a statement from the Commission said.

Because of this, the Commission argues there is a possibility that this dominance may lead to the company dictating the technology standards for distribution of music over the Internet and thus acting as the "gate keeper" in this emerging business.

Not Content with the Content

There's certainly no doubt that an AOL-Time Warner partnership would have an extensive library of music. Following the merger of

Warner Music

and

EMI Group

-- a merger which itself is under a four-month investigation by the EC -- the companies estimate that they would own about 25% of the world's recorded music market.

This issue is made worse by the recent promotion, distribution and sales agreement between AOL and

Bertelsmann Music Group

, the German music recording, publishing and broadcasting group. Bertelsmann, which runs the

RCA

and

Arista

labels, is the world's fourth-largest music business when measured by back catalog.

The upshot of this meant nobody, least of all the market, was shocked by the EC's decision. AOL's shares dipped 5/16, or 0.6%, to 54 3/4 on Monday. Tuesday, AOL shares were trading up 2 1/8, or 3.9%, to 56 5/8 and Time Warner was up 3 1/4, or 4.07%, at 83 3/16.

"If I was consulting for them I would have told them to plan for phase two," says one European-based mergers and acquisitions lawyer for an international law firm, who declined to be named because his firm has provided some services for one of the parties.

The lawyer notes that this deal is the first of its kind to marry traditional content with the new distribution of the Internet and, as such, "a meeting of minds to find out where the competitive dynamics are of this merger" was always in the cards.

There was also the neat timing of the EC's phase two investigation with that of the U.S.

Justice Department

. The EC's investigation will conclude in October, which is around the same time that the Justice Department expects to wrap up its probe.

There is a successful bilateral antitrust agreement between the EU and the U.S. that allows the two organizations to consult on investigations, with the companies' consent, and enables the authorities to agree on common remedies that would allow any merger to go through.

Irritable Regulator Syndrome

Although AOL would only say that "the approval process is on track for the fall," there's no doubt that the companies would have preferred avoiding this extended investigation.

"This phase two is expensive and time-consuming and it can really sour a deal," says the lawyer. "It's not in anybody's interests to see one of these investigations."

It was for that reason that AOL offered the EC some commitments aimed at severing a structural link with Bertelsmann stemming from their joint venture during the initial, or first, phase of the EC investigation. Alas, the EC said that "after examination of the proposed commitments, the Commission has found that they are insufficient to ease the competition concerns raised by the transaction."

Even so, analysts such as Scott Davis of

First Union Securities

remain unperturbed, as evidenced by his strong buy recommendation issued Tuesday on the AOL-Time Warner entity.

He concedes that the partnership between units Warner Music and EMI may result in too much concentration in the music publishing business for the regulators to stomach, but a few asset sales should see this right.

"At the end of the day, I don't think there will be anything to hold up the AOL-Time Warner deal," Davis says. (First Union has no investment banking relationships with either company.)

Although the EC's full investigation is likely to be a source of irritation to the companies in question, AOL and Time Warner can take comfort from the probability that Europe's

Vivendi

will have to face the same music when it comes to its merger with

Seagram

(VO) - Get Report

.